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In his book Winning, General Electric’s Jack Welch famously griped: “It sucks the energy, time, fun, and big dreams out of an organization. It hides opportunity and stunts growth. It brings out the most unproductive behaviors in an organization, from sandbagging to settling for mediocrity.”

“It” is the corporate budgeting process. This much-hated annual exercise in setting targets, doling out resources, and providing incentives for employees is the way nearly all companies run their shops. Even organizations that have adopted monthly or quarterly rolling forecasts as a more agile way of reacting to events still produce a budget, for the most part.

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Now, a few companies are doing what others fantasize about: getting rid of the budget altogether, stomping out the century-old process for good. Their guru is Steve Player, program director at the Beyond Budgeting Round Table, a learning network with more than 50 corporate members. For years, Player has railed against budgeting, which he excoriates as an expensive waste of time. A charismatic consultant and speaker, Player has his converts. Among them is Statoil, the giant Norwegian oil-and-gas company, with $90 billion in 2011 revenue and operations in 36 countries.

Statoil did away with traditional budgeting in 2005, and decided in 2010 to abolish the calendar year in its management processes whenever possible. “Not only does a budget take too much time, it is a bad yardstick for evaluating performance,” contends Bjarte Bogsnes, Statoil vice president of performance management development.

He explains that a budget creates the opportunity for “gaming” the system. “Managers are instructed to deliver on an easy-to-achieve target, told what resources they have to get there, and then are incentivized for hitting that number,” Bogsnes says. “It prevents managers from seizing opportunities to create value.”

Statoil’s radical approach is shared by three other companies profiled below: Elkay Manufacturing, Holt CAT, and Group Health Cooperative. Kenneth Merchant, a professor of accounting at the University of Southern California’s Marshall School of Business, has closely followed the Beyond Budgeting phenomenon, and estimates that at least 100 companies across the globe are on the same path. “A lot fall by the wayside or don’t reach the end destination of no budget at all,” says Merchant, who is also the school’s Deloitte & Touche LLP Chair of Accountancy. “Nevertheless, there is definite value in doing away with the budget,” he adds. “Getting to this point is the problem.”

Sensible but Unreliable
Player doesn’t mince words about his disdain for the “B” word. Budgets, he asserts, can foster unethical behavior and conflicts of interest. “When companies tie incentive compensation to reaching budget goals, they create a huge conflict of interest,” he says. “Managers are incented to submit proposed budgets with low goals. Instead of reaching for outstanding performance, the budget process becomes a game of negotiating the lowest acceptable target, which is often based on assumptions outside the managers’ control.” The process also leads managers to hoard information, says Player, “since no one wants to share information that can be used against them.”

Budgets are also based on assumptions that are frequently wrong. They cost a ton of money, eat up platefuls of time, are out of date by the time they’re produced, and tend to strip local managers of their accountability, since their plans must be squeezed into the company’s goals, Player says. As a method of cost control, budgets are wanting, since managers tend to spend every cent they’ve been allocated, fearing they won’t get the same allocation the following year.

“It’s a management process that can kill the organization,” declares Player. “It’s part of the dumb stuff that finance does and should stop doing.”

Bogsnes generally shares these views. In 2005, he and other senior leaders at Statoil began asking a simple question: Why do we budget? They jotted down a few answers like “using the budget to set financial and production targets,” “to gauge what the following year’s cash flow and financial capacity might be,” and “as a resource-allocation mechanism.” Says Bogsnes: “These were all sensible reasons that were also completely unreliable.”

“Say you’re trying to forecast next year’s financial capacity and cash flow,” he explains. “You start on the revenue side and ask salespeople their views. The problem is they know the number they provide will become the target they have to hit to receive their incentive compensation. You may think you’re engaged in a forecasting process, but you’re actually talking with someone who is negotiating his or her salary.”

Today, Statoil still makes forecasts, sets targets, and allocates resources. It just doesn’t force these different purposes into one single set of budget numbers. “We’ve separated the three areas as a way of inspiring intelligent discussion on each of them,” says Bogsnes. “The goal is to set targets that motivate and inspire people without all the gaming and pay negotiations. We believe the best targets are those set by teams and managers. There’s less top-down cascading and more team ownership and commitment.

“I’m not saying this is an easy process, but it’s easier than budgeting.”

At Statoil, the traditional January-to-December calendar year is a thing of the past, replaced by the setting of long-term targets that might be 18 months and more away and shorter-term horizons of 3 to 4 months. There is no annual process for forecasting the following year; instead, the company hews to an event-based dynamic forecast. A collapse in oil prices or a transportation mishap, for instance, will shift relevant parts of the organization into gear to provide an unbiased forecast of the effect of the event on their targets. Corrective actions, such as a reallocation of resources, may then be required. “Instead of a manager asking, ‘Do I have the budget for this?’ they’re instead determining if continuing to spend the resources they have is the right thing to do,” says Bogsnes.

Elkay Sinks the Budget
At Elkay Manufacturing, the budget hasn’t been buried yet, but the last rites are being read (the transition is being held up by the implementation of an enterprise resource planning system). The 92-year-old sink, cabinetry, water cooler, and food-service equipment manufacturer (with annual revenue in the $500 million to $700 million range) was plagued by the usual budgeting frustrations. “When I got here in 2006, the VP of sales told me the budget wasn’t accurate, no one trusted it, and it got in the way of making effective business decisions,” recalls CFO John Hrudicka. “I realized that if they couldn’t trust the most fundamental analytics by which they drove business decisions, it was a sign that there was no cost accuracy.”

In lieu of the budget, Hrudicka performs elements of continuous forecasting as part of a broader integrated management tool, aided by activity-based costing software that bores into each line item in the P&L. “The software peers into a business unit, then drills down to each customer in that unit, like Home Depot, all the way down to the particular Home Depot store, the products we ship to that store, and each customer order, giving you the profitability each step of the way,” he explains.

Armed with this information, division heads can determine in real time where business is heating up or cooling off. “With a budget, you’re requiring the company to stick to plans with little or no appreciation of how the world has changed,” Hrudicka says. “We’re able to make forecasts on a constant basis, then shift resources where needed.”

For example, in Elkay’s sink business, “the P&L had a line item for finishing costs, like a swirl pattern that we would apply after manufacture,” says Hrudicka. “We’d always figured that free finishing drove sales, but when we drilled into this we learned the cost was disproportionate to the rest of our cost structure. In 30 seconds, the president of that division said, ‘Let’s stop doing the finishing.’ We saved millions of dollars, with very little impact on sales.” Such a decision couldn’t have been made in the past, says Hrudicka, “because no one trusted the analytics.”

Elkay has implemented a balanced-scorecard framework to drive execution and achieve performance targets. The company’s activity-based costing tool profiles full P&L customer and product profitability, integrated into Elkay’s balanced-scorecard framework as well as its customer- relationship-management system.

Once the ERP installation is complete in 2013, “we will rid ourselves of the budget event,” says Hrudicka. “Instead, we will have a continuous planning process that allows us to identify changes in our business environment in real time, assess the changes, and implement initiatives to adapt to them.”

400 Spreadsheets, One Irrelevant Budget
Two other companies, Holt CAT and Group Health Cooperative, are in the thick of similar evolutions. Holt CAT, a Caterpillar dealership in Texas since 1933, grew vastly following the acquisition of a much larger dealership 10 years ago. Last year, the company chalked up $1.2 billion in revenue, a combination of equipment/parts sales and leasing and service fees. “We used to do a budget using spreadsheets, but after the acquisition the process just got more and more unwieldy,” says Paul Hensley, Holt CAT senior vice president of finance and CFO. “We were sending out hundreds of spreadsheets, rolling it all up, and then someone would make a change and we’d go through the exercise all over again. It took half the year to get it done, and at the finish line it was irrelevant anyway.”

Holt budgeted down to hundreds of line items, eventually rolling up a total of 400 spreadsheets for more than 20 locations throughout Texas. “There were errors, and I couldn’t get the numbers to add up, which was very frustrating,” says Hensley. “Forecasts constantly changed, but by the time we learned something was off we were behind the eight ball. For instance, we’d find out that the Department of Transportation [a customer] had lost some funding, but we had no flexibility to adapt to the changing marketplace.”

After seeing a presentation given by Player in 2009, right after a major layoff in the aftermath of the financial crisis, Holt killed the budget and replaced it with continuous planning and rolling forecasts. “I asked the CEO, ‘What do you want me to do with the budget?’ He said that since there was no line of sight as to where things were going, we didn’t need one,” Hensley says. “I’d been talking to Steve [Player] for months about how to transition away from the budget, and I didn’t waste the opportunity.”

In place of the budgeting process, Hensley meets each month with operational managers, and each quarter they revise their forecasts, if necessary, and adjust plans and capital accordingly. To estimate changing expense needs, the team uses financial statement reporting software. When business revived in 2010, the CFO asked the CEO if the budget should be restored. “He replied, ‘No way,’” says Hensley. “We would stick to continuous planning and looking forward.”

Group Health, a Seattle-based integrated health system with $3.5 billion in annual revenue, did away with its annual budgeting exercise in 2009. It had embarked on the journey two years earlier, with the drafting of the 60-year-old cooperative’s first five-year strategic plan, followed by the adoption of a new management system based on lean and continuous-improvement principles, and the implementation of rolling quarterly forecasts. “We were doing detailed, line-item budgets, employee by employee, and we have 10,000 of them,” says Richard Magnuson, chief financial and administrative officer at Group Health.

The cooperative still compiles an operating plan that looks like a traditional budget, but this is purely for company leadership and the board of directors’ perusal and use. “It’s a high-level projection of what we need to hit and achieve, but it doesn’t involve thousands of people in the process,” says Magnuson. “We boil it down to the six or eight main drivers of our financial performance. That’s what we focus on, not all these line items.”

Easier Said than Done
Both Magnuson and Hensley acknowledge that the transition away from the traditional budget was far from easy. Hensley notes that many Holt managers are former military personnel who were used to sticking to a budget, and he encountered both pushback and “using the budget as a security blanket to protect themselves rather than managing the business’s needs.”

“A budget is like a cockroach — you think it’s dead, but then you have to go spray some more Raid on it,” he quips.

Magnuson says the move to the new management process in 2009 was “aggressive,” so the cooperative is adjusting the process as it plans for 2013. “We went from an extremely traditional process to a pretty radical one, and are now coming back to somewhere in between,” he explains. “Our incentive compensation plan still goes off the 12-month calendar, as do our audits. The world is still structured on a calendar-year basis, and that has been a challenge. But that’s what continuous improvement is all about. You don’t just shoot the budget and stand still. You continue finding new ways of doing things better.”

Still, Magnuson has no regrets about eradicating the budgeting exercise. “We’ve freed up finance for more-strategic purposes, and refocused managers on grasping and seizing opportunities,” the CFO says. “The organization used to freeze up for months with everyone trying to do the budget. All that waste is out of the system now.”

To budget or not to budget will continue to consume the attention of CFOs, especially as the spreadsheets start flying in over the transom. Those companies that decide to eliminate the process should be prepared for a multiyear effort. “Most CFOs are busy and don’t have the time to invest in this, because their companies have been downsized and they’ve lost staff,” says the Marshall School’s Merchant. “Even if the CFO is convinced this is the way to go, he or she now has to persuade the CEO, and that’s not always easy, as there are many high-performing companies with a traditional budget.”

Nevertheless, Merchant believes that companies in turbulent industries like technology and oil and gas, where business prospects shift with the winds, would benefit from dynamic forecasting as practiced by Statoil. “Their strategic plan drives everything they do, cascading top-down, so every business unit has strategy in mind before spending money,” he says. “You don’t need a budget for that.”

Russ Banham is a contributing editor at CFO.

Budget BelieversFor most companies, the annual budget works well enough.

As a few dozen companies worldwide do away with the annual budget, the rest of the corporate universe sits on the fence, watching the proceedings with curiosity. They hate budgets just as much, but they’re finding ways of improving the process instead of discarding it.

Among them is publicly traded Cbeyond, an Atlanta-based provider of IT and communications services ($485 million in 2011 revenue). “The primary value of us having a budget is the learning it imparts throughout the organization,” says Robert Fugate, executive vice president and CFO. “It’s a great way for people to step back, examine changes in their areas, and then retest their assumptions. The budget sets them up to make good decisions, even if they later deviate from it.”

“A budget puts the whole organization through a disciplined process, thinking about the general assumptions of the game plan in a top-down manner, and how this fits the long-term business strategy,” agrees Doug Fenstermaker, former CFO of HealthEast Care System, and currently a managing director at Warbird Consulting Partners.

Such views predominate, if for no other reason than many business schools continue to preach the wisdom of the annual budget. “It’s the best way of aligning a company’s mission with its financial operations,” insists Crystal Gifford, professor of finance at Kaplan University in Portsmouth, Ohio. “With a rolling quarterly forecast, what happens if you suddenly find out in October that you’re short $10 million and have to come up with it to ship out products in November? Flexibility is fine, but you still need a budget.”

Sharing this perspective is Miles Ewing, principal at Deloitte Consulting. “The problem with shifting to a 12-month rolling forecast is [the forecasts] end up being these continual superficial top-level planning exercises,” Ewing says. “People complain that a budget takes too long, but because rolling forecasts tend to be done monthly, the amount of effort throughout the year is often the same or more than that of an annual, properly done budget with periodic forecasted course corrections.”

The moral, says Ewing: Don’t throw out the baby with the bathwater. “If your budget is broken, fix it. There is still value in a 12-month forecast, as long as you periodically revisit the assumptions.” — R.B.